Are Stocks About to Repeat Their Summer Horror Show?

Like the third sequel to a summer horror movie, stocks are set up for another summer selloff amid fears that the U.S. economy will slide back into recession.

Source: Dimension Films

Scream 3

“In the last two summers, the final nail in the equities coffin, the thing that pushed it was a double dip scare. We do think the market is going to increase expectations of that in the coming week,” said Barry Knapp, head of U.S. equity portfolio strategy at Barclays.

Tune in to CNBC TV at 9pm ET Sunday for a special report, "Markets in Turmoil."

Stocks are already down about 10 percent from the year’s highs, and analysts expect the choppy trading to continue, now that the May jobs reportFriday confirmed the economy is slowing. The dismal report, showing just 69,000 jobs created, also sparked instant speculation that the Federal Reservewill come to the rescue with another round of easing.

That puts the focus in the week ahead squarely on the Fed, and a series of Fed speeches, the most important of which is testimony from Fed Chairman Ben Bernanke before the Joint Economic Committee Thursday.

“There’s no question the economy is still struggling and still struggling a lot … I’m starting to fear summer," said Diane Swonk, chief economist at Mesirow Financial. "I remember a time when I was a kid and I liked summer. It’s now gotten to where in the last five years, summer is the time everybody falls apart, and we’ve gotten into the pattern, particularly in the last three years where we start out optimistic about the economy and then it falls apart,” she said.

Friday’s market selloff made for the worst start to the month of June for stocks in a decade, with the Dow down 2.2 percent and the S&P 500down 2.5 percent. Traders were also quick to question whether this year, like the past two, will see stocks make their highs for the year in the spring, before a summer swoon. For the week, the Dow lost 2.7 percent to 12,118, and the S&P 500 was down 3 percent at 1278, while Nasdaq was down 3.2 percent at 2747.

Knapp said stocks could be in for a rough summer, with the S&P dipping to 1200 if not lower. Though he doesn't expect a full-on recession.

“You’re going to have a big-time global growth scare, and it would take a big policy response to change the market’s mood about that, and that’s not coming next week," Knapp said. "I think in the next week, the downdraft in the market will be interrupted only by rumors of policy intervention.”

The jobs data, the worst since last August, follow a string of weaker U.S. data, but it also came on the heels of weaker Chinese manufacturingdata. There is a cluster of other important Chinese data set for release at the end of the week, including retail sales, inflation data and industrial production. The concerns about slowing global growth, evidenced in China and now the U.S., compound worries about Europe’s sovereign debt crisis, which is now circling Spain and its banks.

“We need to see a big reacceleration, and I’m not sure we’re going to see a big reacceleration into the end of the year,” said Swonk, on “Squawk Box.” “I don’t think it’s QE3 yet. I think the Fed has to keep what little powder it has dry … They’re not sure how much they can do to move the needle, but Europe is a big issue here. You add Europe to this uncertainty here and it’s why people are pulling back on hiring.”

“This alone doesn’t bring the Fed back in — but this combined with Europe brings the Fed back in,” Swonk said in a later phone interview.

Knapp said he doesn’t expect the Fed to take action at its June 19-20 meeting but it could do so later. Stocks have "gone down between 15 and 20 percent before the Fed has contemplated policy response. Credit spreads have widened half as much as they did in 2010, and three-quarters as much as they did last year,” he said. “You haven’t even had financial conditions tightening enough to justify the Fed doing anything.”

One event that could break the market’s fall would be if the election outcome becomes more clear, particularly if Republican Mitt Romneystarts to take a clear lead, Knapp said. “I honestly don’t think Fed response would do much for the market anyway,” he said.

Euro Drama

The European Central Bank meets Wednesday for its regular policy meeting on rates and there is speculation it could consider cutting its 1-percent interest rate at this meeting or a later one. There were also market rumors Friday it would embark on a new program to purchase debt of the weakest sovereigns.

European Central Bank President Mario Draghi holds a press briefing after the Wednesday meeting. In the past week, he said the setup of the euro zone was unsustainable and called for European deposit guarantees and the formation of a banking union, proposed by the European Commission.

“I don’t think there’s much doubt in the minds of most market participants that the global economy is going through a pretty significant slowing. We probably haven’t seen the worst of the impact of some of the stresses going on in Europe. We’ve now shifted from uncertainty about the degree of slowdown to uncertainty about the policy response,” said Robert Sinche, chief global currency strategist at RBS.

Sinche does not expect a rate cut this week. “I think they’re probably torn, and I think they are concerned that if they move too soon, they could limit the incentive of the policy makers and government leaders to address the more structural issues,” he said. “I think they probably feel better about an ease because of the decline of commodity prices and the profile of inflation going forward.”

Some analysts say the ECB may also be waiting for the Greek electionon June 17 to see if they need to take action in response to the outcome of the vote. The market fears a government will be elected that opposes the bailout and resulting austerity measures, triggering a Greek exit from the euro.

Meanwhile, as that fear gripped markets, driving stocks lower and Treasury yields lower, Spain’s efforts to nationalize Bankia put the spotlight on the Spanish banking sector and Spain’s fiscal issues. Spain is expected to auction bonds this coming Thursday. Its 10-year note was yielding more than 6.5 percent Friday.

In response to worries about larger contagion, investors dove into the relative safety of German bunds and U.S. Treasurys, driving yields to record lows in the past week. The German 2-year yield went negative, and the 10-year Treasury ended Friday at a record 1.46 percent. The euro was down 0.7 for the week against the dollar, finishing at 1.2435. The dollar index was 0.5 percent.

Gold, also benefiting as a safe haven, gained 3.3 percent for the week, to $1620.50. Oil prices fell sharply, with WTI down 8.4 percent to $83.23 per barrel and the international benchmark Brent, off 7.9 percent, at $98.43 per barrel.

Econorama

In the U.S., there is a series of data in the coming week, the most important of which is weekly jobless claims. There is also trade data and ISM nonmanufacturing data, which measures the services sector. The claims data in the past week showed a surprising increase, the seventh week in eight where the number of claims rose.

“It’s a pretty light week, and aside from Bernanke’s speech, that’s going to be the biggest economic indicator,” said Stephen Stanley, chief economist at Pierpont Securities.

Markets will be watching Bernanke for any suggestion on easing and his view on the economy. Some of Friday’s market speculation about the Fed focuses on it extending its current “Operation Twist,” a program under which it buys longer-dated Treasurys and sells shorter-dated notes.

“If you look at the cover ratios, they’re kind of falling off. I feel like we’re limping to the finish line,” Stanley said of Operation Twist. The program was scheduled to end at the end of the month, and prior to the jobs report, many in the market thought the Fed would allow the program to expire.

Now, there’s even talk the Fed could embark on a new quantitative easing program, or “QE3” where it would buy Treasury securities or mortgages and add them to its balance sheet.

“They’ve never done exactly the same thing every time. I think what would make sense, it seems to me, one logical option would be to extend the Operation Twist and maybe buy mortgages instead of Treasurys, or buy some combination of mortgages and long-term Treasurys,” said Ward McCarthy, chief financial economist at Jefferies.

McCarthy does not expect Bernanke to tip the Fed’s hand on easing when he speaks to Congress Thursday. “Hell keep his cards close to his vest as far as monetary policy goes,” he said. “He’ll talk about the downside risk from both Europe and Washington, and he’ll probably use the “R” word which politicians don’t like to hear, especially when it’s their job on the line in an election year,” said McCarthy.

There are a few earnings in the week ahead, including Dollar General Monday; Hovnanian on Tuesday; Brown Foreman on Wednesday, and Lululemon Athletica , Cooper Cos, and JM Smucker on Thursday.